Question

The ABC. Inc . has 2.8 million shares of stock outstanding . The stock currently sells for $20 per share . The firm debt publicly traded and was recently quoted at 94% of face value . It has a total face value of $ 10 million and it is currently priced to yield 10% .The risk -free rate is 8% and the market risk premium is 7% . You have estimated that the company has a beta of 0.74 . If the corporate tax rate is 34% ,what is the weighted average cost of capital ?

Answer 1

Weight of Capital Components based on the Market Value

Market Value of Debt = $94,00,000 [$1,00,00,000 x 94%]

Market Value of Equity = $5,60,00,000 [28,00,000 Shares x $20 per share]

Total market Value = $6,54,00,000 [$94,00,000 + $5,60,00,000]

Weight of Debt = 0.1437 [$94,00,000 / $6,54,00,000]

Weight of Equity = 0.8563 [$560,00,000 / $654,00,000]

After-tax Cost of Debt

After-tax Cost of Debt = Bond Yield x (1 – Tax Rate)

= 10% x (1 – 0.34)

= 10% x 0.66

= 6.60%

Cost of Equity

Cost of Equity = Risk-free Rate + [Beta x Market Risk Premium]

= 8% + [0.74 x 7%]

= 8% + 5.18%

= 13.18%

Weighted average cost of capital (WACC)

Weighted average cost of capital (WACC) = [After-tax Cost of Debt x Weight of Debt] + [Cost of Equity x Weight of Equity]

= [6.60% x 0.1437] + [13.18% x 0.8563]

= 0.95% + 11.28%

= 12.23%

“Therefore, the Weighted average cost of capital (WACC) would be 12.23%”